Jeremy Torobin

Why the Bank of Canada plays coy on interest rates

OTTAWA — The Globe and Mail

Bank of Canada Governor Mark Carney walks to a news conference in this 2009 photo. Mr. Carney holds four scheduled press conferences in Ottawa a year to explain his latest forecasts and policy decisions. (BLAIR GABLE/REUTERS)

As central banks go, the Bank of Canada is about as transparent as it gets.

Former Governor David Dodge sought to demystify monetary policy for Canadians through an unprecedented 90-some speeches over his seven-year term. At the rate Mark Carney’s speaking schedule is going, he’ll have given just as many if not several more by the time his term ends in early 2015. Plus, in keeping with standard practice, Mr. Carney holds four scheduled press conferences in Ottawa a year to explain his latest forecasts and policy decisions. U.S. Federal Reserve Chairman Ben Bernanke just started facing reporters on a semi-regular basis last year, the first Fed chief to do so.

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“The Bank places a great deal of importance on communication,” John Murray, one of Mr. Carney’s deputy governors, said Monday in a speech in Vancouver. “It is a critical part of our accountability to Canadians and enhances the effectiveness of monetary policy by deepening the public’s understanding of the economy and our actions.”

Still, Mr. Carney once said the bank’s job is not to provide “perfect foresight” about its plans. And, in truth, the extreme lack of certainty about how global events will play out from one month to the next makes it very hard for the decision-makers themselves to know what they might do next. Indeed, since interest-rate moves have their most impact long after they’re made, policy “has to be forward-looking,” Mr. Murray said in his speech to the Mortgage Brokers Association of British Columbia, “and policy-makers are forced to make their decisions in conditions of considerable uncertainty.”

So the best they can do is reinforce a few key themes guiding their thinking. This is especially crucial now, because policy makers have repeatedly hinted at their discomfort with interest rates being on hold since September, 2010 -- the bank's longest pause since the 1950s -- and have indicated that rate hikes are coming, but without spelling out when because, well, even they probably don't know.

Mr. Murray’s speech is the bank’s latest crack at debunking “popular misconceptions” about how it makes decisions. For one thing, he said, a focus on achieving 2-per cent inflation does not ignore objectives like “full employment” or rising living standards, because the certainty that “low, stable and predictable inflation” gives consumers and businesses has “helped to encourage more stable economic growth” and “lower and less-variable unemployment.”

Second, he said, the bank has leeway to use interest rates to guard against financial imbalances like excess credit growth in “exceptional circumstances,” even though other avenues like tighter mortgage rules “are typically the first lines of defence,” and even though inflation remains the bank's chief goal. Price stability and financial stability, he said, are “inextricably linked,” echoing an argument Mr. Carney has made in light of lessons that policy makers learned from the U.S. housing crisis.

And perhaps most significant, Mr. Murray issued a fresh assertion that the bank does not buy the notion that interest rates have to be much closer to ‘normal’ or ‘neutral’ -- around 3 per cent, compared to the current 1-per cent -- when the economy is nearing full capacity or else inflation could get out of hand.

“If there were no forces acting on the economy to push it away from this desired state, the statement would be true,” he said. “Headwinds and tailwinds are often present, threatening to push economic activity and inflation higher or lower. Monetary policy needs to lean against these forces with opposing pressure from higher or lower interest rates in order to stabilize the economy and to keep inflation on target.”

Mr. Carney has made this point repeatedly, arguing that he retains “considerable flexibility” to not follow “mechanical rules.”

The overall message?

Essentially, if household debt levels keep rising and Mr. Carney feels the only thing that will stop them is higher rates, he will tighten policy even if inflationary pressures elsewhere in the economy do not scream out for a hike. At the same time, even as the economy looks on track to hit full capacity earlier than Mr. Carney was expecting -- prompting him to warn last month that rate hikes “may become appropriate” -- he cannot ignore things like stalling momentum in the United States, or renewed concerns about Europe, that could knock Canada's economy off course. Which means he is ready to move when and if it makes sense to, but will be careful and proceed very gradually once he does.